CASE 1.3 Holton-Central Holdings Inc. Holton Chairs had been an innovative designer and producer of quality office chairs since Arnold Holton founded the firm in Grand Rapids, Michigan, in 1938. In 1947 Holton purchased Central Chairs and renamed itself Holton-Central Inc. When Mr. Holton died in 1994, long-time executives managed the firm for his heirs. Through a variety of circumstances, including foreign competition, outdated production equipment and processes, expensive wage contracts, and low quality, Holton- Central gradually became unprofitable. In early 2009, Holton-Central Inc., .declared bankruptcy and closed its doors. Because of concerns about chemical contaminants at Holton-Central's original factory (no longer in use), no one would buy the corporation as a going concern. Instead, one bidder offered to buy Holton-Central's assets, except for the original factory, and resume operations at the current production facility under the Holton-Central name That bidder, Belmont Office Furniture, produced high-quality office desks. Peter Cardell purchased Belmont Office Furniture's assets out of bankruptcy in 2003 within four years he increased revenues by 65% and returned Belmont to profitability. By 2009, Mr. Cardell decided to acquire another office furniture company. On July 1 2009, the Holton-Central bankruptcy judge accepted Belmont's $4,765,000 offer for Holton-Central's assets and accounts payable. The $4,765,000 purchase price equaled the market value of the tangible assets, minus $875.000 of accounts payable, plus $265,000, which Mr. Cardell considered goodwill: Raw material inventory Work-in-process inventory Finished goods inventory Equipment (5-year life) Building (20-year life) $175,000 5220,000 $115,000 $450,000 $3,600,000 $815,000 $5,375,000 $875,000 $4,500,000 $265,000 $4,765,000 Land Total tangible assets Less: Accounts payable Net tangible assets Goodwill Total purchase price On July 1,2009, the acquisition was completed as follows: for all 3,900,000 shares of Holton-Central Holdings' S.01 par value common stock. bankruptcy, the principal would be repaid in six $1 million payments each July 1, 1. Belmont Office Furniture formed Holton-Central Holdings and paid $3.9 million 2. Holton-Central Holdings borrowed $6,000,000 to help Holton-Central exit from SECTION ONE INTROUCTORY CasES beginning July 1, 2010 Also due each July 1, beginning July 1, 2010, was 10% interest on the unpaid balance as of the previous July I 3. Holton-Central Holdings paid $4.765.000 cash for the assets of Holton-Central Inc., and assumed the firm's $875,000 of accounts payable. July 2, 2009-December 31, 2009 Mr. Cardell's first action was to close four furniture showrooms in Chicago, Los Angeles, New York, and Atlanta, because the leases had been cancelled in bankruptcy. These closures would save $950,000 annually: Mr. Cardell believed sales would decline only marginally. He also negotiated a more favorable labor contract with former employees, which would save another $750,000 annually. On July 2 2009, the firm reopened for business. The following is a summary of Holton-Central's activity for the second half of 2009 1. Paid the $875,000 of accounts payable. 2. Paid $154,500 for utilities, professional services, and other administrative 3. Paid $1,408,000 for office wages and related payroll taxes and benefits. 4. Paid $2,785,000 for selling and marketing expenses. 5. Paid S900,000 for production machinery. The machinery was purchased October, 2009. The machinery had a useful life of five years with no salvage value 6. Paid $228,000 for various one-year insurance policies 7. Purchased $5,345,000 of raw material: $835,000 was unpaid as of December 31, 1998 8 Manufacturing records showed $4,935,000 of raw material transferred to work in 9. Paid S7,878,000 in cash for production wages and charged the costs to work-in- process inventory. 10. Charged $6,662,000 to work-in-process inventory for manufacturing overhead items, including $6,400,000 paid in cash and $262,000 for depreciation on manufacturing facilities 11. Manufacturing records showed $19,123.000 of work-in-process inventory transferred to finished goods inventory. 12. Sold chairs for $25,563,000. Of that, $4,587,000 had not been paid as of December 31, 2008 13. Manufacturing records showed cost of goods sold of $18,593,000. 14. Recorded depreciation expense of $86,000 15. Recorded accrued interest expense. 16. Recorded insurance expense of $95,000. 17. In late December, Mr. Cardell received a call from Holton-Central's largest customer. To cut costs, previous management had substituted a low-grade fabric on 1,800 chairs that the customer purchased in 2008 and 2009. Repairing those chairs would cost $360,000. Mr. Cardell estimated that customers would request repairs to another several thousand chairs, which would cost another $560,000. Although that liability was discharged in bankruptcy, Mr. Cardell believed failure to repair the chairs would irreparably damage the firm's reputation. He notified customers that Holton-Central would repair the chairs at no cost 18. Computed income tax expense of $365,000 for 2009, payable in 2010 CASE 1.3HOLTON-CENTRAL HOLDINGS INC Required 1. Prepare and record journal entries for Holton-Central's sale of stock, incurrence of debt, and the 18 activities listed above. 2. Prepare a balance sheet as of December 31, 2009, and an income statement and statement of cash flows for the period July 1, 2009, through December 31, 2009. 3. Evaluate Holton-Central's performance during its first six months of operations